Applied Islamic Banking

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

In the contemporary socio-economic environment it had been a desire for decades to adapt with a promising commercial return the practices of Islamic banking and finance. Islamic banking system had been successfully developed ever since 1963. The Islamic Development Bank (IDB), which was established in 1974 in Jeddah, became the role model to the world to expand Islamic banking and financial practices. To day in the early 2001 st century Islamic banking and finance have emerged in a new reality in the global market with their Divine philosophies, governing principles, product innovations and sustainable returns in accordance with the spirit of the Qur’an and Sunnah.

A significant development in Muslim world in 1970s and 1980s was pan Islamic movement. This movement aimed to bring back the glory of Islam and began to demand the application of Shari’ah in all aspects of life. The establishment of Islamic banks and financial institutions sign the manifestations of the ‘back to religious movement’. Therefore, the emergence and expansion of an Islamic banking system will be the starting point of a new era of Muslim world.

The introduction of Islamic banking and Takaful in Malaysia is due to the manifestations of the Islamization policy of Mahathir administration in Malaysia. Separate Islamic legislation and banking regulations existing side-by-side in line with conventional banking system. Islamic banking in Malaysia governed with Islamic Banking Act (IBA), which came in force on 7 th April 1983. IBA provides Bank Negara Malaysia (BNM) with powers to supervise and regulate Islamic banking operations .

The first Islamic banking system established in Malaysia was Bank Islam Malaysia Bhd (BIMB) in 1983. BIMB’s operations are based on Shari’ah principles. The establishment of BIMB was the idea of Malaysian government to support Muslim population by encouraging them to participate in commercial activities those are opposed to the elements of usury (riba).

Islamic banking operations has been appreciated widely in Muslim and in non Muslim countries. It gives different perspectives in dealing with banking and financial practices. Muslim need banking services as much as anyone for many purposes like to finance the new business, to buy a house, to facilitate capital investment, to undertake trading activities and to offer a safe place for savings.

The Central idea of an Islamic Bank approved by the General Secretariat of the Organization of the Islamic Conference (OIC) is;

“ An Islamic Bank is a financial institution, which applied statutes, rules and procedures expressly state its commitment to the principles of Islamic Shari’ah and prohibit of receiving and laying of interest (riba) on any of its operations” (M.A, Mannan, 1982).

In Islam, it is strongly prohibiting riba or usury transactions, which are the primary concept adopted in conventional bank Riba transaction, would lead injustice and this is contradicted with Islamic principles. Islam is the religion that enshrines justice and fairness in the society. This paper also will discuss the objective of Islamic bank, is to facilitate socio-economic dealings and satisfy the customers’ need with banking and finance services based on Shari’ah rulings.

The paper will also discuss the Shari’ah rulings, which are the sources of Islamic law applicable in Islamic Banking. The holy Qur’an, Sunnah, Qiyas and Ijtihad, which directly facilitate to develop the guidelines and regulatory framework governing Islamic Banking and finance. The Shari’ah disallows riba and there is now a general consensus among Muslim economists that riba is not restricted to usury but encompasses interest as well.

The fundamental concepts of modern Islamic Banking had been discussed in mid 1940s. Later, the model for Islamic banking appeared in mid 1950s, but comprehensive and detailed concepts for interest-free banking only appeared in late 1960s. The first experiment in Islamic banking was set up undercover in Mit Ghamr, Egypt in 1963.The model for the experiment was the German savings bank modified to comply with Islamic principles i.e. prohibition of riba.

In 1970s, Islamic banking has emerged as a new reality in the international finance view. The philosophies and principles have been outlined in the Holy Quran and Sunnah of Prophet Muhammad (p.u.b.h). The emergence of Islamic banking is often related to revival of Islam and the interest of Muslims to live accordance with the Islamic teachings. (Josh Martin, 1996)

In 1974, the Islamic Development Bank (IDB) was established as a result of Islamic conference of Foreign Minister about the` Institution of an Islamic Bank, Economics and Islamic Doctrines’. Then, it followed by Dubai Islamic Bank in 1975, Faisal Islamic Bank of Sudan in 1977, Faisal Islamic Egyptian Bank and Islamic Bank of Jordan in 1978, Islamic Bank of Bahrain in 1979, the International Islamic Bank of Investment and Development, Luxembourg in 1980 and BIMB in 1983. Nowadays, there are more than a hundred financial institutions, which claim to be operating partially, or fully of an interest-free basis in 34 countries (Islamic Banking in Malaysia).

The first Islamic bank developed in Malaysia was Bank Islam Malaysia Bhd (BIMB), which commenced operations on 1 July1983.All the banking operations and activities are based on Syariah principles. After more than a decade in operations, BIMB has proved to be viable banking institution with its activity expanding rapidly throughout the country with a network of 80 branches and 1,200 employees. The bank was listed on Main Board of Kuala Lumpur Stock Exchange on 17 January 1992.

Then, ten years later, dual banking system was introduced. Most of banks and financial institutions in Malaysia have opened Islamic windows to provide banking services. The emergence of Islamic banks and financial institutions or Islamic windows in Malaysia should have valid sources of jurisprudence as a guideline in dealing with banking system.

On 1 st October 1999, a second Islamic bank, namely Bank Muamalat Malaysia Berhad (BMMB) commenced operations. The establishment of BMMB was the effect of the spin-off following the merger between Bank Bumiputra Malaysia Berhad and Bank of Commerce Berhad. Under the merger arrangement, the assets and liabilities of these two banks were combine together to form two banks which is the Islamic bank, BMMB and the conventional bank which is Bumiputra of Commerce Berhad(BOCB). BMMB was given 40 branches in various locations in Malaysia due to this merger process.

The main objective of setting up Islamic Bank is to practice the application of what Allah’s directed in the field of economics, dealings, transactions and liberating the Islamic communities from Islamic prohibitions.

Establishment of Islamic Banks showed that how Islamic principles in banking and finance have been adapted to the operations. Application of Islamic principles in this industry has promote Islamic communities and satisfy the needs of society in general in applying better regulatory framework in banking industry. A large portion of the Muslim world had been dominated culturally, economically and politically by colonial powers. Even though Muslims have achieved independence from their colonial masters, the colonial principles are still deep rooted in the social, economic, political and cultural life of Muslim communities. Islamic bank will solve social and economic problems due to Islamic legislation encompasses all evolutions of human life and respond to the advanced requirements of life. It is a process of liberating Muslims from the burden of supremacy by western thought, values, institutions and remodeling their social and economic life in accordance with Shariah.

In general, Islam strictly prohibits paying and receiving interest. However in Islam, productivity of capital is recognized. Therefore, providing capital for an economic activity and sharing of profit or loss is allowed as well as charging higher price for deferred payments in trade. In principle; there are two main concepts, which are profit and loss sharing scheme and financing techniques based on permissible profits from trade (Beate Reszat, 1995).

The issue of Riba has been discussed for long time ago. The issue of what constituted Riba itself has been a subject under serious discussion. The existence of Riba has been debated to be the main factor for the law participation of the Malays in the economic activities of Malaysia. The establishment of BIMB is the big step towards and interest-free financial system in Malaysia.

The purpose of all commercial banks is to conduct their business purely on profit maximization. Commercial bank tries to plan and formulate policies to earn higher profit rather than providing services to economic and social development. On the other hand, the objective of Islamic bank is not purely to make profit but also to create balanced economic society. The objective of Islamic bank is to earn profit but not profiteering. Maximization of profit does not create welfare to society at large. Therefore, in Islam, profiteering is prohibited and avoided by Islamic bank. Islamic bank eliminate the transaction involving riba, accumulation of capital and wealth in few hands and hoarding of goods.

Shariah rulings of Islamic Banking

Sources of Islamic law

The origin and basis of Islamic banking is shariah. It is referred to Islamic law or jurisprudence in the faith and belief of a muslim, Islam is religion revealed by Allah to Prophet Muhammad (p.b.u.h). Islam is a complete religion, encompasses comprehensively of world life and affairs in the world hereafter. The teachings of Islam cover everything including economic well-being and development of Muslims at individual, family, society, state and “ummah” (or Islamic universal community) levels.

Illustration above is on Islamic view of a Muslim life and the place of economic activities including banking and financing activities within the framework of such a view. Islam may be perceived as comprising three basic elements. The first element is Aqidah, which concerns all form of faith and belief by a muslim in Allah and His Will, from the fundamental faith and belief. Thirdly, is akhlaq which is relates to behavior, attitude and work ethics with which a Muslim performs his practical actions.

Shariah should be practiced in all aspects of Muslim’s daily life. It can be divided

into two, Ibadat and Muamalat Ibadat is concerned with the practicalities of his worship to Allah, in the context of man-to-Allah relationship whereas Muamalat concerned with the practicalities of his Mundane daily life, in the context of various forms of man-to-man relationship.

The importance segment of Muamalat is the conduct of Muslim’s economic activities within his economic system and also within economic system is the banking and financial system where he conducts his bank and financial activities. Therefore, the Islamic scheme of life and Shariah framework a banking and financial activities can be traced to his economic activities, to Muamalat, to Shariah, to Islam and finally to Allah. This is the root of Islamic banking and finance.

There are two different legal approaches among Islamic thinkers in two prevailing schools of legal thought. The first approach is by traditionalists (ahl al-hadith), which rely solely on Quran and Sunnah (traditions) of the Prophet. They felt Quran and Sunnah are the only valid sources for jurisprudence. The second approach known as non-traditional approach (ah al-ray’) rely on the free use of reasoning and opinion in the absence of reliable Hadith. Non-traditional approach proclaim in Iraq whereas the traditional approach in heralded in Medina. The differences arose between these two approaches due to there are abundance of reliable Hadith that scholar could depend in forming legislation in Medina the scholar could directly refer to Prophet during his life in forming the legislation. On the other hand, in Iraq, the sources that were available were not as reliable as in Medina. This is the main reason why jurists had to turn to analogy due to their circumstances. Due to differences among Muslim thinkers, a Hadith may have been accepted by Malik (from Medina) and not by Abu Hanifa (from Iraq) who had use analogy in the absence of reliable hadith. Therefore, the sources of Islamic law in Islamic banking could be discussed from these two approaches

Throughout history, the Muslim jurists would determine the legality of an issue of these sources in descending the order. If the legality was not based on an explicit command in the Quran, then the jurists turned to refer for explicit commands in the hadith, qiyas and ijma. Unfortunately, not all aspects of the methodology were unanimously agreed upon, the Quran could be interpreted differently, some traditions of the Prophet were questioned for their authenticity and to what extent they were religiously imperative, the use of analogies was greatly debated and there was little unanimous agreement among scholars in Islamic history about unclear issues (www.aibim.com.my)

The Quran

Within Islamic scheme of life and shariah framework, Islam imposes its ahkam or laws or norms or values (in modern terminology). These norms are not man-made; Allah ordained it. These laws are derived from the sources of shariah.

The Quran is the main sources in Islamic law to derive Shariah rulings. The Shariah, foundations of Islamic law, are derived from verses from Quran.

“The bulk of Quranic matter consists many of broad, general more directives as to what the aims and aspirations of Muslim should be, the ‘ought’ of the Islamic religious ethic”

Quran provide many directives and the scope is very wide, therefore interpretation play significant role. There have been enemy interpretations of the Quran, claim widely read and hard to find any command with an agreed in agreed interpretation.

“Here is a plain statement to mankind, a guidance and instruction to those who fear God”

Quran thought oneness of God and guided believers to the path of morality and justice. The existence on money in early days was recognized in Islam since during the life of Prophet Muhammad (PUBH). The concept of Islamic banking has been introduced on this early state to avoid wrong/doings and wrong action in dealing with transaction. For example in Quran, it is clearly stated the prohibition of riba or usury. In verse following verses:

“Oh you who believe! Observe your duty to Allah and give up what remain (due to you) from usury if you are in truth believer” (2:278)

Even though, Quran provide very basic or fundamental guidelines to give right directions to all Muslims, any Muslim scholar or institution has never questioned the authenticity of Quran. This is due to Allah revealed Quran through the Angel Gabriel to Prophet Muhammad.

The relationship between Islamic teachings and Islamic banking and financial framework.

The above diagram try to show that the relationship between Islamic teaching which is primarily based on Quran and Sunnah gives the general and fundamental guideline in the operation to Islamic banking and financial framework. Economic framework and banking and financial framework is a subset of Islamic worldview. The concept in Islamic bank like al-mudharabah, al-musharakah, al-wadiah, bai-bithamain ajil should comply with Islamic teachings deals with halal and haram. Halal(legal) is the transactions which are permissible under Islamic law and Haram (illegal) is the transactions which are not permissible under Islamic law.

Quran and Sunnah of the prophet are under primary sources of Islamic law, which is Divine revelation to mankind. These laws are arranged into the following scheme of five levels.

Fard or wajib- An obligatory duty, the omission of which is punishable.
Mandub or mustahab-An action, which is rewarded, but the omission is not punishable.
Jaiz or Mubah.-An action which is permitted and the law is indifferent.
Makruh_ An action that is disliked yet not punishable but the omission is rewarded.
Haram-An action which is absolutely forbidden and punishable.

Bank and financial activities being part and parcel of Islamic Muamalat are therefore subject to the Shariah laws on Muamalat

Besides Quran, Sunnah is another primary source of law. The rules stipulated in Sunnah are divided into three kinds which are closely related to the Quran’s stipulation (S.H Hamoud, 1985).

Rules, which conform to the Quran- which hadith that explain the necessity of prayer, fast, zakat and pilgrimage in order to confirm with Quran stipulation.
Rules, which explain the stipulation of Quran, detailing what needs to be explained, specifying the general or restricting the absolute.
New rules having no origin in the Quran, that is opinions of some scholars but considers that all was brought by the Sunnah has origin in the Book (S.H Hamoud, 1985,p.80)

The rules concerning banning usury are obvious. Sunnah has discussed in both divisions- Sales and debt usury. The narrations have been attributed to Prophet (P.b.u.h). It is Arabic word which means “method” of a legal term to represent of what the prophet said, did and agreed to. The sunnah of the prophet generally means of “tradition” and includes sayings of the prophet; his deeds; his silent or tacit approval of certain acts which we had knowledge of. The record of Prophet’s words and deeds were recorded in narrative a hadith, a reports that were transmitted before finally being complied in authoritative collections decades after the death of the prophet.

As the last Messenger of Allah, Muhammad (570-632) brought the Quranic teachings to the life through his interpretation and implementation as the leader of Muslim community. Allah mention in the Quran in surah 33:211

The clarity of the concept of usury is not really clear because it only involve little discussions from the Prophet (p.b.uh). In 9 th year of Hijra is the first time Prophet dealt with the subject f Pre-Islamic usury. At that time, Thaqeef claimed their debts from Bani Magheera the remaining balance from Pre-Islamic usury. At that time Quran was revealed containing the verse ordering abandonment of the remaining of usury when the prophet wrote to his governor of Mecca. The letter mentioned that:

“Every usury of Pre-Islam must be abandoned entirely; you are entitled to recover your principal sums (capital) only so that you do not oppress (by looking an increase) nor be oppressed (by taking less)”

“ Every usury is abolished, but you are entitled to recover your principal sums (capital) such as you do not oppress (by taking more) nor be oppressed (by taking less), God judged that no usury can be charged and entire usury of Abbas bin Adil Muttalib must be abandoned”

Thus, the Sunnah, which is relevant to debts usury, falls within the scope of the first kind which confirms the relevant stipulations of the Quran.

Hadith attributed from the Prophet (pbuh) also concern to sale usury. It is refer to the sale of gold for gold, silver for silver with delayed payment usury, which is deemed by the Shariah to be usury. The hadith reports on this kind of usury relates to sales where the exchange items are from the six items. The six items are gold for gold, silver for silver, wheat grains for wheat grains, barley for barley, dates for dates, and salt for salt, similar for similar in equal payments and from hand to hand; where the sale concern other items you may sell as you please if the sale from hand to hand.

In seventh year of hijra, the ban on sales upon usury of the same kind and of two kinds of usury items was imposed after the revelation of Surah al-Imran and Surah al-Baqara. Al-Bakhari and Muslim quoted “ gold for gold, silver for silver, wheat grains for wheat grains, barley for barley, dates for dates and salt for salt, similar for similar in equivalents and from hand to hand (on the spot); where the sale concerns other items you may sell as you please if the sale is from hand to hand”.

Where the exchanged items are the same kind-i.e. gold for gold, silver for silver(usury of increase is forbid)
Where the exchanged items are the different kinds- You may sell as you please where the items to be exchanged are available at the place of sale (from hand to hand) if delayed payment is usury.

With regard to equity financing, Quran does not dealt with that and left to Sunnah to clarify the issue. Sunnah simply affirmed “ Uqud al Ishtirak” (profit sharing contracts) of al-Mudaraba, al-Musharakah and extensively with debt financing. Islam allows both equity financing and debt financing. Equity financing is to be affected through profit-sharing contracts with debt financing is to be effected through deferred contracts of exchange.

The third source of law, qiyas, is reasoning by analogy. To apply qiyas to similar cases, the reason or cause of the rule must be clear. The use of analogies greatly varied among the scholars.

The main operation of qiyas is to predetermine to the significant extent by the volume of textual statements. The constitutions of such statements amounted only to fractional portion of the body of legal propositions (W.B. Hallaq, 1996). The size of their portion was further narrowed down by objectives that were raised concerning those legal propositions, which fell on the fine line between what is viewed as “speech” which is clearly stated in text of Quran and Sunnah. On the other hand, the “less clear speech” is the latter application being subject to legal analysis and influential reasoning.

Legal propositions are required as the instruments to make analogy. However, the linguistic and and modern scholars conceive that qiyas as a term which exclusively denotes analogy. By referring to qiyas, it is tough to justified and need certain degree to understand the concept of single argument that slightly not accepted by the certain extreme by sunni.

The emergence of Islamic bank, Muslims scholars may argue the concept and method use by Islamic bank in order to make it acceptable to Shariah Section (3) of IBA provides the Shariah Advisory Council to advise the bank in the operation of its banking business to ensure conformity of Shariah.

Qiyas and Ijtihad are categorized as a secondary source of Islamic law. Its value is derived from Quran and Sunnah. Ijma constitutes of unanimous agreement of a group of jurists of a particular age on a specific issue and constitutes the fourth and final source of law in Shafie methodology. Jurists will apply their own reasoning if they find there is nothing in Quran and Sunnah regarding the issues discussed. Through time, many lawyers would accept from this interpretation given by agreement of a group of jurists. On the other hand, the unanimous agreements are rarely happened among intellectual elite and since there were always diverse opinions, one could always find several scholars of the day who concurred on an issue.

There are certain scenarios of Islamic banking transaction common practice in Islamic countries. Although Allah had commended His people do not acts anything contradicts with His guidelines but nowadays some Islamic banking try to practice and had influenced by Western culture in banking. All these practice have a large effect on Muslim business community. These scenarios can be classified according to the business environment such as Interest banking, profit and loss sharing, sale with markup, lease, and advance purchase. How Islamic law applies to these transactions and what Islamic religion allows and did allow to business when do such kind of these practice.

Interest banking scenario: Riba

In Islamic banking transaction, interest known as Riba is strongly prohibited. Allah has prohibited us to deal with the transactions that would involve riba. There are many questions arise with this transactions like;

What are factors derive the rule of Riba? Why the sale of Wheat transaction now for the salt later be prohibited? Why the loan borrowing for high later payment is not allowed? Who would engage in such a transaction? What reason s it not permissible to demand increase for delay in payment of a debt or loan? And what sources to prove the forbidden of Riba transaction in Islam?

In the commercial sectors, businesses that are carrying small or giant traders often face a shortage of fund or capital in their economic activities. It is a true fact; none of the traders can escape from this matter. To solve this matter they naturally apply for the capital suppliers from the bank or from any person who are rich. This term goes as the term of loan transaction. The term of capital supplies incurred and it gives the bad impact to mankind and for the whole Islamic country. This matter is not deal with any individual; it faces with mankind for the life of now and for the life in the hereafter. In Islamic environment interest banking is also a strong practice. This interest banking is known as riba and Allah prohibited this transaction since it involve with high sin of something in return. As stated earlier, on what transaction of the bank to be allowed and forbidden, there is one issue in Islamic law that forbids interest loan (or paying interest on the bank deposit), which is called riba. This forbid has mentioned clearly on chapter 2, verse 278, 279 in the Holy Quran that:

“ O you who believe! Be afraid for Allah and give up what remain (due to you) from Riba (usury) (from now on ward), if you are (really) believers” (2: 278)

“And if you do not do it, then take a notice of war from Allah and His Messenger but if you repent, you shall have your capital sums. Deal not unjustly (by asking more than your capital sums) and you shall not be dealt with unjustly (by receiving less than your capital sums)”. (2: 279).

These two verses of the Quran explain clearly the important thing of forbidden of Riba. If you follow or obey this teaching, then Allah will reward you. But in reality this teaching was not follow 100%. Some Islamic Banks try not to follow this practice and they know that it will lead to injustice and Islamic law is against all forms of injustice. According to Ofmyrus, he said that “the poor becomes poorer and rich becomes richer”. The reason behind this statement is that about the interest (Riba). This is because poor family is unable to repay the debt eventually in order to settle this problem the poor families have to sell their shelter even sell their children into prostitution. Is it justice for the poor people? Ohmyrur said, “Islamic Banking is not Islamic”. It may be the cause of Riba. Islamic Banking is the true mode of financing or nor if its practice is under Riba. In fact, we cannot deny the interest-based system of banking which is not strictly based on the principles and spirit of Shariah.

The term of riba can be understood in many ways by different sources. All these definitions are based on the concentration of incremental value of the transaction between the two persons (lenders and borrowers, bankers and customers.) Riba is not only cover in one area but it can be in different field in economic. For example, in daily life also incur riba. The meaning of Riba can be defined and understood as the lending of money at illegal high rate of interest. But in Islam Riba is different meaning.

Ribatechnically prefer to the premium that must be paid by the borrower to the lender along the amount principal (amount as a condition for the loan) with increment amount. This can know as an extra amount in one of two homogeneous equivalents being exchanged without the increase by return for time. It is the lending of money on interest. It is the cause of any risk, independence of any labor or effort. Allah has strictly forbidden Riba. However, the world today, including the Muslim world, is influenced with Riba. The Prophet Muhammad has confirmed this teaching in Hadith reported from Abu Hurairah;

“Their will come a time, he said, when you will not be able to find a single person in the world who will not be consuming Riba. And if any claim that he is not consuming Riba then surely the rapor of Riba will reach him”.

Riba is considered as a grave sin in Islam. The Hadith above implied that no one could escape from Riba. The true believers must wage the greatest possible struggle to keep himself and his family free from Riba, to guard himself from Riba. If he does not fight himself from Riba and does not respond to oppression in the world where caused by Riba then his faith is empty.

Riba is forbidden irrespective of business nature, it prohibits in all form whether in the form of consumption or production. Any payment relates for a loan and it’s compensating of time for a high rate of return value is considered as Riba.

Literally: Riba in Arabic comes from the roof word “raba” mean to cut or to prosper and in the qur’an had mentioned the meaning of riba.

There are certain views of jurists about riba. Some of them are unanimous with the loan transaction such as Malaki held the view that the lenders or borrower can pay or receipt profit of the loan which is contradict by Allah but Shariah and Hambali schools are not agree in this transaction.

What the amount of interest value can consider as Riba? The amount receive from the riba is prohibited event it is as small rate or high rate (from 1%-25%) It does not mean that the amount of interest as 50-100% wills the case of Riba. Riba never defines as undue profit.

“O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may (really) prosper”

Islamic law prohibits Riba as a predetermine payment on borrowed funds irrespective of the purpose for which the funds are used. According to the purpose of used, Muslim jusrists classify Riba into two forms: Riba al nasiah and Riba al- fald.

This term in Arabic knows as to “postpone” Muslim identifies this Riba In loan as giving to the lender a fixed increment after interval of time over the fixed period and increase of credit over the principal. On the other hand riba al nasi’ah prefer to the repayment in the period which instrumental in earning for the lenders a fixed increment rather than delays in repayment. This was common practice in the pre- Islamic and in the early Islamic era. This form of riba established in all credit transaction where loan was advanced to person on the payment of monthly interest over the principal. In case the debtor unable to repay the principal and accumulate surplus, he will receive an extension of time to pay the loan but at the same time the sum of payment has increased double. In this sense of practice, the Qur’an has prohibited it in surah al Baqarah verse 276-278.This forbidden was not limit the transaction even this is in the consumption or product loans transaction. In legal terminology of the shariah, riba defined as surplus, profit or increase in loan and sale and it spreads in all economic sectors, in trades commerce and credit for no equivalent return. Therefore, the practice of riba is unlawful for Islamic because the greater benefit is given to the rich who becomes richer whilst the poor and weak suffers. And from this is will creates different socio- economic classes in society. Ulama' have come to a outcome regarding the Riba in banks. In one of the legal compendiums, they declared:

"An interest transaction in banks is classified as Riba al-Nasi'ah. This can occur in two ways, when someone deposits their valuable or when someone borrows money ( al-Qard ) for a period of time and incurs interest either way. Therefore its unlawfulness is the same as the prohibition of Riba and this sin is the same as the sin of involving in Riba ."

Riba al – fadl : riba al –fadl describe as excess over and above the quantity of the commodity advance by the lender to borrower. This is known as exchange of something with different amount of quantity. And this also considers as riba which has been prohibited in qur’an and sunnah.

Riba and Investments in Shares:

Regarding shares and stock market investments, Ulama' have classified this under the category of Awraq al-Naqdiyyah. Basically this is something, which is allowed, with certain conditions and it is also subjected to Zakah payment, provided that it fulfils the Nisab and Hawl and its Nisbah is 2.5% of its value.

"Shares is defined as, one of the equal parts into which the capital of a company is divided, entitling the holder of the share to a proportion of the profits. […] Dealing in shares is permissible in the Shari'ah."

"Money in Islam has a role to play. It should not be kept away, hoarded in a vault or safe but should circulate to allow people to make use of its benefits. That is why the books of Fiqh say that the guardian of an orphan must invest that inheritance in a good manner so that Zakah would not deplete the wealth of the child”.

You can buy shares in any company, which is offering good services to the community, and companies, which do not pursue unlawful trade. For example, we are not allowed to buy into the banking sector because it is ridden with interest. We are not allowed to buy shares into breweries because they are producing something, which is Haram. We are not permitted to buy shares in chemical companies, which produce products, which damage people and the environment. But companies, which are good, pose no problem.

Riba has been mentioned in 12 verses in four surah in the qur’anic: these entire sources represent Riba as a opposite of positive activities of trade daily activities. These Qur’anic verses were the 1 st to prohibit Riba among Muslim believers such as Surah al-Nisa verses 160-161.

“For the iniquity of the Jews We made unlawful for them certain (foods) good and wholesome which had been lawful for them; in that they hindered many from Allah’s Way”

And “That they took usury, though they were forbidden; and that they devoured men’s substance wrongfully; we have prepared for those among them who reject faith a grievous punishment.”

These Surah want to inform the Muslim about Riba, which regarded to the practice of Jewish and it was prohibited between Jews. Riba has been the first mentioned in the Qur’an. It has prohibited for the Muslim Ummah. In the verse 130 of Surah Al-Imran, Qur’an has been mentioned any person involve in any transaction that double or multiplied the value are in the case of Riba.

“O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may (really) prosper”

The nature of Riba is under the entire tribes sign the indebtedness to the lender. This practice was common in the pre-Islamic usurers, the repayments amount was double of the original loan .It was prohibited compound usury.

Surah al Baqurah 2:275-281 says to the effect: that whose involve in Riba will accompanies by a treat of the hereafter

“ Those who devour usury will not stand except as stand one whom……but who repeat the ( offence) are companions of the five, they a hide there in ( for ever ) “ ( surah 2:275-281)

The meaning of Riba and interpretation of the verse (30:39) was confirmed the subject in which Allah, the most high commended among the acts of the Jews in taking Riba and it had been prohibited for them. Riba in the Qur’an has mentioned as a system of economic injustice and it will lead to evil. Riba comes from exploitation and oppression that is sometime canceled in ultimate disguised .It is essentially the lending of money on interest and the influence of Riba was directed toward the realization and preservation of social justice and unity of society. Riba is the most powerful and most dangerous attaches upon mankind.

In the early years, Riba has been described as ‘ increase in capital at the expense of wealth of other’ it can be understood as Riba is the loss of one the power become poor and the gain of other (the rich become richer) .It is not fair for the Muslim ummah . Allah does not allow us to do this. This business transaction does not the good attribute of the business, rather than it is the opposite of business of religious. Allah, Almighty allows only the permissible transaction (Halal) and Riba is forbidden (haram). In Islam, all aspect of business transaction should be done in mutual consent and each of the parties should gain the satisfaction among themselves in the business transaction. This was stated in Surah al Nisa 4.29

But let there be amongst you Traffic and trade by mutual good-will: Nor kill (or destroy) yourselves: for verily Allah hath been to you Most Merciful!”

The first teaching of Islam spread to the mankind in the Qur’an regarding the matter of Riba. It was specifically related to the case of lending and borrowing. Lending should be use only for the purpose of helping those are in need and it is humanitarian institution, the lenders and borrowers have bond close relationship of spiritualized. And this relationship ought to be a human, fraternal. When the lenders do not involve in any Riba (give higher rate (interest) to the user) lender will become predator. On the other hand, lenders’ wealth will become witnessed in destroying at fraternity and destabilizing the social order. Riba will be the case of destroying the concept of society as family where formerly the community was the insurance, which insured individuals against losses; now individuals have to find for themselves such as in the insurance case. This type of transaction is closely inter-linked with Riba. There is evil life for those were engaged in Riba for the purpose of seeking the wealth of mankind. The Qur’an has stated that “Those who engaged in Riba and never give up his action then he will take note of war from Allah and His messenger

Riba, which has been existed in the Prophet Muhammad lifetime and it practice until modern day.

If RM.100 000 were lent at a compound rate of 10% per annum for two years, the borrower would be called upon to repay RM 121 000 at the end of the contract. The lender can achieve the same goal by offering RM.100 000 at the simple rate of 21%. What would be the grounds for distinguishing between the two arrangements? Likewise, the term "exorbitant rate of interest" is also arbitrary. A 10% rate of interest may be exorbitant for one person while 21% may be normal for another depending on their respective financial positions and prospective uses of funds.

There are several hadiths suggest the divine prohibition of riba. The Prophet has explained the various injunctions against riba to his companion. There are two hadith relevant to the concern of riba, which has been the most influential in shaping the fiqh conception of riba:

The second hadith is related to common practice in the modern economic life. Profit on loan is banned without regard to whether the fungible subject matters of the loan. In the Hadith of Prophet Muhammad said:

“ …a man would sleep and honesty would be taken from his heart and only it trace will remain in his heart…” Bukhari.

This is a sign for those who conduct any transaction of Riba in the last Day of Judgment. Riba has blinded Muslim, Riba has destroyed value, and corrupted mankind and non-can be trusted.

In the book of Imran Hussein, he had taken one example about Riba has practiced or has been fulfilled in miserable lifetime He mentions, “One man from othaman Khalifa had borrowed money on interest from Europe. This amount of interest is over his effort, at the end, this man submits to European financial black mail…” He has mentioned about the financial imperialism. This is common practice in the Muslim world nowadays. This action is not mentioned in the qur’an.

In the world to day Riba can be many other forms, which are readily identifiable by businessmen. Some of businessmen will glue new form of Riba. Muslim must make them aware of the different form of Riba, and must exercise the greatest care to avoid them. Some forms of buying and selling money today take the form of borrowing from a bank on interest. It is a form of Riba and is strictly prohibited. The Prophet had taught that when the two things are bought and exchanged not the same in nature or equal money value is invalid such as gold for silver.

Most of the Islamic Bank nowadays practices in form of profit and loss sharing. Some said that the form of profit and loss sharing is not a form of Riba. How this form works in the Islamic banking system. The explanation is that when the depositors place their saving in the bank and the bank provides the fund to businessmen in exchange for a share of profit or loss. The depositor may not take interst instead of profit because the Quran and Sunnah have prohibited any received in the form of Riba but the profit is not forbidden in the Quran even in the Sunnah. Why interest is forbidden but profit is not? Profit is fixed depends on certain area of investment. This is the different way between interest and profit or we can explain that when the depositor put money in their saving account they will receipt a fixed amount of money, which regard of interest, but when they decide to go for the profit and loss sharing they will not receive the fixed amount of money. And this money may be higher than or may be lesser than depend on the business investment. The more successful project the more the bank will earn and pass it down to depositor. This is known as the two tiers Mudaraba. The risk assumed by the depositor enables the institution to tolerate greater risk on its assets, as it must if it is to make equity investments in mudaraba ventures instead of lending on interest. According to some Islamic Scholar, this form is injustice because some depositor may not want to take the risk on the investment. They should be shared the loss with bank when the project go deeply bad. They do not want to take a risk. He or she just needs to get and to be assured with a little return (interest) for his other bank deposit. It is not faith for those who want to take high risk for his/her capital. This form of profit and loss sharing will bring opportunities for businessmen who took the bank’s money to report a loss. This is common practice nowadays for the businessperson. By doing this the businessmen do not need to share any profit with the bank. Under the Islamic world financial system, unprincipled businessmen will try to report a profit into a loss project by changing or creating the account. Is it an ethical practice? To prevent this practice, some Islamic banking institution has offer certain Islamic legal to facing this Islamic banking model such as law in protesting the amount of deposits, how to organize the fund using conventional legal form in corporation. And protect depositor from the risk transaction.

According to Ohmyrus, he said that Murabaha transaction follow the conventional financing. There is no difference between Murabaha (in Islamic law) and conventional transaction. Murabaha can be known as to sell at a profit. The bank would buy some goods for cash and sell it to the customer for a credit at higher price than that for which it was purchased (and it resell to the client) it can be at read interest. The payment can be one full pay or by installment over many years. The risk will bind to bank that the client cannot honor it agreement to pay up, as this point can we see the point that is same with conventional banking? An Islamic scholar, Justice taqi Usmani said:

“Islamic banks are using the instrument of Muradaha within the framework of the conventional benchmarks. Where the net result is the same from interest-based transaction.”

We agree with this point, actually now this practice has been influenced many in Islamic banking. Islamic banks around the world are attempting to by-pass Riba through the process of Muradaha. The money would increase in consideration of time. It would be same as Riba. In the Quran stated that:

“These Lord, are the men who led us astray. Let their punishment be doubled in the fire” (7:38)

The main teaching of this verse that Allah will punish those misguided Muslim who obstinate cling to this false Murabaha should fear Allah. The double punishment will bound to those stop misguiding Muslim. Some bankers are agreed that this transaction is halal because since there is agreement on the new price between the bank and client to make whether the transaction is halal or haram we look into one example follows: the bank was brought the land for $ 30000 cash and then sell it to the client with the price of $ 45000 cash in the same market in which it was purchased. Why the client would pay $ 45000 cash for a land when the market price is only $ 30000. This is the case where the buyer unaware of the market price, and the seller exploited the buyer ignorance. So can we see this transaction is halal or haram. It constitutes Riba transaction. One of Islamic scholar Anas ibn Malik said that the Messenger of Allah said:

The main objective of modern banking, conventional is to handle credit, debts or loan. As we know that credit and debts are the two aspects of loan. There is a relationship between the two credits and debt with the loan. It can be explained further that credit pertains to the loan-giver in relation to the loan; debt pertains to the loan-receiver in relation to the loan. The bank deals with its clients are revealed in the details of its financial position as presented in its balance sheet. The balance sheet is divided into two parts: resource of funds and use of funds. The resource of fund (liabilities) usually controlled by the loan contract. This resource of fund comes from the depositors. The depositors can be known as loan-giver and the bank is loan-receiver in return for interest, which the bank pays. The bank takes the money from the depositor as an asset and uses it as merchant, investment. There will be a difference from total interest that the depositor receives from the bank and total interest where the bank receives from those making use of its financial resource represents the bank’s net return. The bank’s net return can be a Riba transaction. This is a nature of modern banking. The depositor as only receive amount fixed rate but the bank is not Riba. Riba will lead to Fasad. Ness, corruption, decays, immorally and so on. In the Quran, Allah mentioned in surah 30 verse 41 that:

“Corruption has appeared on land and see because of that which the hand of men had earned that Allah may give them a taste of (the consequences of) some of their deeds, in order that they may turn away from evil”.

The transaction, which called purchase with markup, has numerous attractions for Islamic investor and bank because these transactions can either be short term or long term It give a fixed amount for unconditional debt. It reduce the need of monitor the customer’s business, with it percentage of markup it will mimics interest –lending, lowering costs from conventional bank.

Case: Mr. Jonh is delivery a new computer equipments to its in Malaysia. The dealer will not pay for these equipments until the equipment landed in Malaysia; it requires Mr Jonh to finance the computer equipment in the Malaysia bank in other to identify the equipment (As Murabaha term) the diagram illustrative for this case as:

Leasing is known as installment sale for financing purchase of equipment. This defers from the installment sale the leasor retains legal title to the property being financed and this will affect security interest. Islamic law of leasing gives the three problems for modern Islamic finance all arising from riba principles. The first is the concerns limitation on the right of the parties to fix the nature of the right sold in their agreement such as the law provides the duty to repair the good falls always and solely on the leasors since the repair benefit him as owner and the repair cost will impose to the lessee, and they would increase the rent in an amount undeterminable in advance. The second problem is the property is not tangible or it does not exist. This bears with the risk and unstable in the future value. Islamic laws give a wide scope to the lessee to cancel the lease when the cause of the usufruct to be less valuable than expected. This scenario will give full understanding regard to the lease transaction: Mr B enters a lease contract with Hong Kong Security Company to lease for $1000 per year a theft control system worth $10000 today. This lease contract will run 10 years even though the aspects equipment life is 15 years. At the end of the 10 years contract, Mr B decide the option either to purchase this equipment for $2000 or to return back the equipment to the leasor. The present value of the lease payments plus the present value of the salvage value at the end of the lease should equal $10000 at the leasor’s desired annually opportunity rate of return capital.

It is necessary for all Muslim community not to practice the prohibition of riba and such kinds of transactions contrary with the teaching of Allah and His messenger Prophet Muhammad. The model of Islamic banking nowadays is growing, certain transactions which attracts to Islam business, to people who wish to do business therefore to encourage this people Islamic finance institution should practice more or open more transactions according to the shariah principles not in the Western practice. In such matter Islamic state has issue certain legal law regarding the prohibition of the riba according to the Quran and there are certain organization were established for the right of man such as the council of Islamic word league give some decision regarding to the riba banking for the people who are dealing with them and the legal opinion on taking interest. This form of unlawfulness is condemned by the book, the sunnah and the consensus of Muslim and all these sources had explained clearly why it was prohibited and what is the punished from Allah if we involved in this. All Muslim are known that these were a kind of sin .It is not like a normal sin which we cannot count in the seven sin. The Holy Qur’an threatens usurers with war from Allah and his messenger (surah Baqarah 278-279) It has been verified that the Prophet, Allah’s condemned those who take, give, write about and witness usury will involve the riba.

Further more Islamic banking need to consider as socio-economic. All Islamic banks should focus on this consideration as a main goal for the total Islamic banking feature. However to achieve this objective we should considered the establishment of Islamic banking in a total Islamic system. That means the Islamic system much achieve the objective of socio economic such as provide the application loan for all member of society, it provides for the comprehensive and compulsory payment according to the require of the religion for example Muslims are require to pay Zakat and Ushar which no other system has so far tried.

One thing need to consideration in Islamic system that all the banks should follow the shariah ruling and necessarily will be acting in conformity with Islamic law, as we know Islamic law give the freedom for the banker to do all the transactions which is subject to an important limitation For all these reasons, Islamic bank established the Shariah Supervisory Board. This Board should consist of trustworthy scholars who are highly qualified to issue fatawa (religious ruling) on financial transaction. The Board should provide the existence of shariah, whose fatawa and resolution should be binding upon the financial institution’s management. And it should be formed in the sense from the moment the financial institution is incorporated and furthermore it needs to provide continued supervision and permanent checking of contracts, transactions and procedures.

Islamic bank is well rooted in the banking system in Malaysia. There are two Islamic banks in Malaysia, which are Bank Islam Malaysia Bhd and bank Muamalat Malaysia Bhd. Not only these two banks but also most of conventional bank in Malaysia has its own Islamic windows in their service. The establishment of Islamic banking in Malaysia is strongly support by the government. Bank Negara Malaysia has given the right direction and guidance to ensure that Islamic banking becomes a true viable alternative banking system.

Islamic banking operation is based on Qur’an prohibition of charging interest. Islamic bank does not involve in any kind of transactions that involve riba. The Qur’an prohibits charging of riba on money lent. The Shariah consists of the Quranic commands us laid down in the Holy Qur’an the words and the deeds of Prophet Muhammahd (PBUH). There are four sources of Islamic law in islamic bank which are Qur’an, sunnah, Qiyas and Ijtihad. Qur’an and Sunnah are the most fundamental aspect that all Muslims should be referred to the Qur’an and Sunnah known as primary sources where as Qiyas and Ijtihad is secondary sources.

In practice the concept of Islamic bank had been accepted widely. This is because Islamic bank has economic rationale for eliminating interest is based on the values of justice, efficiency and stability. In my opinion, the emergence of Islamic bank in modern economic and financial transactions provides the services based on Islamic teaching to complete with conventional bank.